Wednesday, April 15, 2009

Looking For Relative Weakness

"The greatest trick the Devil ever pulled was convincing the world he didn't exist." -- Keyser Soze

The job of a bear market rally is to convince as many people as possible that the bear is over. The more pessimistic speculators are in the preceding plunge, the more more violent the subsequent rally must be to change their minds.

This holds true for individual stocks, sectors and entire indices. The same goes for corrections in a bull market. It took a massive crash like that of '87 to convince enough people that the bull market was over - immediately before embarking on a 12 year mania.

I've covered where I think this rally will go and how long it will last in my technical updates. But as it progresses, my eyes will shift away from potential long candidates (as I showed back on Mar 3 with "On Bottom Fishing") and toward short opportunities.

In doing so, I will be employing a similar tactic of looking for certain sectors or individual companies that have not participated much in this rally. There are some differences in the method, however. When looking for potential candidates for a bear market rally one should look at the unwillingness of a certain stock or sector to surpass previous lows while broad indices have done so. Or one can look at the total decline from the peak price. But when looking for candidates to lead the next leg of the bear market, I will be looking at the percentage recovery between the peak price and the lows.

In other words, just because financials may have doubled over the last 5 weeks, the recovery is quite mild in comparison to it's peak price. The chart below highlights a number of different indices and sectors along with their percentage recovery from peak prices.

(Note: peak prices for the various indices occurred at different times. Homebuilders peaked in '05. I used '07 peak prices for the Nikkei and Nasdaq - not their absolute peaks many years before)

When used in combination with other indicators, the relative weak recoveries of those on the bottom of this list could be a signal for underperformance during the next leg down. I stress "in combination with..." because any indicator used on it's own is useless. I would also take note of whether or not the security has passed it's early January peak or not, divergence late in the rally, volume and a number of other factors.

As such, my eyes are focused on the utilities, financials, health care and energy producers. I could have also added crude oil and copper to the list above. However, beware that just because these commodities have traded in tandem with the overall economy and markets for quite a while, they won't always do so. Correlations between asset classes often break down as soon as the average person believes they are gospel.

Keep in mind that I do believe this rally has much further to go and will likely be interrupted by a very convincing correction somewhere along the way. How these sectors and the others perform during that correction and the subsequent rally to new YTD highs will be of great interest to me in determining what I will be shorting. As will be the individual sector reactions to earnings reports. Keep your eyes and ears open for bottom callers and steadily rising sentiment indicators. I don't think the coming top will be marked with token analyst bullishness. It will be "common knowledge" that the worst has passed and "happy days" are here again.

I would also note that the next leg down will be characteristically different from the first. I fully expect to see many names go to zero and others to stay relatively buoyant (although relative strength to zero isn't difficult). The retail space specifically has an enormous dichotomy. Some companies like Best Buy (BBY) and Wal-Mart (WMT) have hardly budged while others like ones that rhyme with "Lacy's" and "Mannequin Hands" are looking atrocious. Just because the retail sector has been doing very well of late does not mean there are not opportunities. You have to dig deep to find the weak ones. For legal reasons I won't be doing much of that here (too many bloggers have been served with "anti-defamation" suits for suggesting specific shorts - ludicrous, I know. Apparently free speech is no more).

Is there anything that my readers have their eyes on? Am I missing something in the list above? Can I finish this post without slipping in a little "Go Canucks Go!" nugget?

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Beat the Blues said...


I have nowhere near the knowledge needed to be playing with stocks, or even with indices. But I find it very interesting to read and learn.

I agree that this rally in the markets is just a temporary bear market rally. You also say that you expect to see this bear rally experience a deep correction followed by more rally highs in the months ahead. Basically, the way I read you is you don't expect the next stockmarket drop to be the end of this bear rally continuing over the next 3 to 6 months (reading from your previous posts). Is this just a gut feeling you have, or is there something more to your analysis?

Matt Stiles said...

Beat the Blues!,

Sometimes I feel the same way as you about "not having the knowledge needed to play with stocks or indices." Even after watching nearly every tick for 3 years there are times when the market humbles me. In previous instances, I found myself trading anyway and losing just to have something to do. I've made 2 trades in the last 5 weeks and taken losses on neither of them, which for me is a big step forward. As Mr. Market likes to say, "Son, if you don't remain humble, I'll do it for you." Yes, Sir.

As far as the interruption of the rally that I sense, it is part gut, part analysis. Very little ever goes in one direction. And something to scare the pants off the bulls (like a terrible report from a big name) could incite the "here we go again" mentality. But there are also a number of Elliott Wave patterns open to interpretation - many of which involve a large correction. My DeMark people also tell me that we should be expecting a near term correction.

Perhaps I'll cover this more in my Technical Update on the weekend.


Beat the Blues said...

(1 down 3 to go!)

Yes, I've tried to read up on Elliot wave theory, but I get a little lost 1/2 way through the info on investopedia. It seems to be way more technical than I can understand at this time. I prefer to watch the macro changes - maybe jump in when the markets are at a major turning point.

So, I am expecting to see a major turn at some point, as the markets must go down much farther in my opinion. I'm curious what indicators you see for a continuing up trend. I suppose it's along the lines of market trends have many small peaks and valleys along the way - something like the fractal nature of trends and Elliot wave theory.

DeMark - can you explain a little what this service gives you? Is this "DeMark Indicators"? I'm always on the look out for information on analysing macro market trends (hopefully not as complicated as Elliot wave theory seems to be).

I look forward to your next technical analysis.

Thanks Matt.

Matt Stiles said...

Beat the Blues,

You're on the right track. Don't bother with the indicators for now. The macro stuff is far more applicable to the average person.

I'm a beginner with both Elliott and DeMark, so explaining them probably wouldn't be of much benefit. What I do know is that they are measures of mass psychology - which is what I believe is the main driver of the markets, in contradiction with the "news drives markets" mantra parroted by who else but the media.

I'd suggest reading "Economics in one lesson" by Henry Hazlitt to give you a good backgrounder on economics. The understanding you get from that will provide you with a base to branch out from.

Whatever you do, don't touch a Macroeconomics 101 textbook. :)

Namke von Federlein said...

Hi Matt;

People do business with people. Just my opinion. Charts are nice. People are not nice. Just look at the markets today?

Since your blog is always loaded with tidbits - I'll pass one one.

In Europe, the privately held companies are just spectacular. You might be thinking booze, food, tourism and technology. Actually - private investors in Europe own and control a lot more than you might suspect at first glance.

However, to get a chance to invest in it you may need to find out where private offshore investment companies rub elbows with their prospects. And an old Namke expression : if it isn't where it has to be, it has to be where it can't be.

And about inflation : I was pondering your thinking a bit. I would guess that everybody is headed in the same direction - demographic inflation/deflation calculations.

In other words - tuition doubles. What does a retired person care? Yet - their benefits are indexed to some useless idea that inflation is all things to all people. One size fits all is not going to work any more?

And that is what I respect so much about your blog. You don't just report - you question the numbers. You challenge the thinking.

Just rambling a bit here...

Thanks for your insights!

Namke von Federlein said...

Forgot to mention : Over the last couple of years (yes - the last couple of years) I've been building a geographic map of the post credit-crisis world.

According to my map - you are right. Canada will be number one in the world. Just thought I'd pass it on.

Target date for full confirm : May 12th, 2010. I would suggest : Carney will be doing something that the Swiss had done in the past : offering negative interest rates to non-Canadian depositors in Canadian banks. (That's a good thing).

Look out immigration Canada! When Bush won his second term the web site accesses at Immigration Canada soared. When the US monetization starts sniffing the butts of the tax returns of the richest in the USA - here they come.

This summer will see a ton of US money headed into Canada's cottage country. Next year will see millions of naturalized Americans heading for Canada.

And the richest Americans know something simple - in most of Canada there is no death tax.

So, Matt - you put predictions on the record. Here are a couple for the record.

1) in the next 2 years 3 million Americans will attempt to move to Canada
2) the Canadian dollar will got to $ 1.20 USD
3) Canada will be the only G20 country in the world in 2010 that will produce a balanced budget - despite the currently planned deficit of (roughly) 30 billion dollars. And despite those morons name Harper (Reform Party pimped out pute for oil and gas) and Flaherty (east coast loves a perfectly good lie).

Just for fun.

Beat the Blues said...

Yes, I have a hard time believing anything from a textbook written these days, if the author's anything like the talking heads and college professors all over the news in the last couple of years. ;)

Thanks for the tip on Henry Hazlitt.

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